March 31, 2012 mortgage delinquencies are showing mixed results. Based on March, 2012 Call Reports, total delinquencies for all bank-owned residential mortgages (totalling $3.7T) increased slightly while multi-families and commercials continued to drop (see below).

It is interesting to note, however, that if you segregate HELOCs and 2nds from the residential numbers, the resi-1sts actually declined while the 2nds showed some material deterioration.

2nds have heretofore have been relatively impervious to the real estate downturn. Possibly, this was due to tougher underwriting guidelines for these products. Studies show, however, that even high FICO borrowers have their limits and that when adjusted LTVs rise above 115%, they tend to mail in the keys. These borrowers may be finally hitting the wall on making their payments on underwater mortgages . This needs watching.

Everyone knows there is a relationship between the cost of a mortgage loan and the borrower’s credit strength. The precise relationship, however, is less clear. Lenders expend a great deal of resources to determine the true cost of defaults so that their pricing is accurate on a risk adjusted basis. Level 1 Loans has examined seventeen of the largest lenders’ rate sheets to quantify the effect that credit scores and loan-to-values have on their pricing; all other product characteristics were held constant. We examined the pricing of a hypothetical loan with the following characteristics:

$300,000 principal balance; 1st lien;

4.50% fixed rate coupon; 30 year term;

Collateralized by property located in Ohio;

Full documentation; conventional

We looked at pricing from our database of the major aggregators’ product offerings, underwriting guidelines, stipulations and rate sheets. This data is updated daily. The results (below) show a spread of 310 basis points between the highest price offered for this hypothetical loan (102.17 @ 60% LTV & 780 FICO) and the lowest (99.07 @ 95% LTV & 620 FICO). As can be seen, this is not a linear function. In fact, pricing is almost flat for FICOs >= 720 with LTVs >= 65%. Below this 720 threshold, however, the expectation of losses climbs and prices plummet.

Loss expectations are driven by the probability of default (PD%) and the severity of a projected loss, i.e. the loss given default (LGD%). While mortgage lending is a behavioral science, and many demographic factors relate to mortgagor defaults, we have limited this review to loan-to-value and credit scores. The PD% is primarily driven by credit score, while the LGD% is more a function of LTV; although the two are inextricably intertwined. Credit scores have minimal impact on pricing at the lower LTVs (62 bp swing @ 60% LTV) while they influence pricing by 285 bps at 95% LTV. Likewise, LTV variations have de minimus impact on pricing (26 bps) at credit scores over 720 but a 248 bp swing in pricing for the lower credit score mortgagors.

On a $300,000 loan, a swing in pricing of 310 basis points implies expected losses of approximately $9,300. This expected cost is passed onto the mortgagor in terms of either upfront points and/or a higher coupon.